How the Stock Market may view Market Consistent

How the Stock Market may view Market Consistent Valuations John Hele, Deputy CFO ING Group Market-consistent Valuation of Insurance Contracts 2 nd November 2006

Key points to make • Investors and analysts are not satisfied with current disclosure by insurers • EEV has not solved the issue, and perhaps made it worse • MCEV is viewed as a positive step toward better valuations • Solvency II is also seen as a big positive • A fair value balance sheet is viewed by the IASB as the future direction for insurance 2 November 2006 2

Basis for Conclusions • Research reports: • Morgan Stanley “European Insurance – What the Market Thinks” (Sept. 5 2006) • Merrill Lynch “European Insurance – EEV-er more complicated” (Sept. 5, 2006) • Bear Sterns “European Insurance – Market Consistent or Inconsistent? ” (June 12 2006) • Fox Pitt Kelton “European Insurance – Solvency II The Invisible Force” • Ernst and Young: “European Embedded Value Results” (June 2006) • IASB Update – October 2006 2 November 2006 3

Investors find reporting Opaque Which valuation metrics do you find most useful in valuing insurance stocks? (Participants were allowed three responses) The diversity of answers to this question may be illustrative of the general opacity of reporting in the insurance sector. See also the comments in relation to slide 5. • Source: Morgan. Stanley Research 2 November 2006 4

EEV Reporting has not really helped Has ‘European Embedded Value’ reporting improved the transparency and compatibility of life insurers’ reporting? One question that we maybe should have (but failed to) include in our survey would have concentrated on investors’ ‘satisfaction’ with the quality of current reporting. If we had asked such a question, we suspect that most investors would have been critical of reporting. It is against this background that the answers to the questions here should be judged. The majority of respondents believe that EEV has ‘somewhat’ improved reporting – but we do not think that this should be interpreted as investors yet being satisfied with the quality of reporting. • Source: Morgan. Stanley Research 2 November 2006 5

EEV – not the answer • European Embedded Value • Introduced by CFO Forum to gain better disclosure and comparability of embedded value results by European insurers • NPV of statutory book profits less a cost of capital • The quantity and quality of disclosure has improved significantly • But the comparability of results is still an issue • • • 2 November 2006 Risk Discount Rates Non financial risks Required Capital and cost of capital Financial Options and Guarantees MCEV Source: E&Y 6

EEV- Risk Discount Rates • Bottom Up Approach • Typically using market consistent approaches • Or assigning a beta to cash flows of business units or products • Top Down Approach Source: E&Y • WACC 2 November 2006 7

EEV- Non-financial risks Source: E&Y 2 November 2006 8

EEV- Required Capital • Internal model based on risk approaches • Economic capital • Solvency II type calculations • S&P formula model • For a targeted rating • Minimum EU Solvency I • No capital for agency costs • A wide range of results 2 November 2006 9

2 November 2006 8, 5% Not disclosed 3, 6% 21, 3% 7, 6% 12, 1% 3, 7% 10, 5% 5, 9% 10 2, 3% Not disclosed Resolution Winterthur 16, 2% Standard 7, 1% Life Swiss Re 3, 2% Skandia 3, 0% Prudential Old Mutual 2, 4% Munich Re 7, 7% Legal & General 0, 7% Generali ING Fortis Friends Provident CNP AEGON Allianz Aviva AXA EEV- FOGs TVOG/PVIF % Source: E&Y

EEV - Views • ML- “EEV – Frozen in the headlights” • “The move to EEV standards turned out to be the antithesis of what it was intended to be…in short we believe the new generation of embedded values has dazed rather than dazzled investors and valuation complexity continues to be a barrier to investing in European insurance stocks. ” • BS- “EEV Principles have Major Shortcomings” • “the major problem that remains is that there is no mechanism to link the embedded value discount rate with the underlying risk profile of the business. ” 2 November 2006 11

MCEV is viewed as a positive • BS – “MCEV is to become the standard” • “there is a growing consensus that MCEV is the only coherent approach” • ML – “Expect EVs to move to a market consistent approach” • “this will at least give more consistency from company to company. Against this, understanding embedded values and how they work will continue to be a significant challenge” • “MCEV tends to give higher FOGs charge but lower COC” 2 November 2006 12

Solvency II is also a positive step • FPK “The invisible force” • “S II will progressively transform the insurance industry’s economics by having a significant influence on: • • • Corporate strategy Risk appetite Product design Pricing Capital structure Level and volatility of profits” • “We think the real power of the regulation is in the increased focus on companies to move towards risk based product pricing and capital deployment” 2 November 2006 13

Diversification based on market rates Example: AXA Capital International 2, 3 Insurance 11, 2 P&C Total Group Geographic diversification benefits: -35% benefits: -46% 1, 6 Segment diversification benefits: -17% 5, 7 Life Diversification 19, 1 21, 9 15, 5 Sum of Economic Sum of Segments’ AXA Group Capital of local operations Economic Capital Source: AXA 2 November 2006 14

IASB is converging to market consistency • Phase II Accounting – October 2006 Update • All insurance liabilities, including non-life, should be discounted • Measurement basis for insurance liabilities should be the amount the insurer would expect to pay today if it transferred all of its remaining contractual rights to another entity (‘current exit value’) • Measurement of an insurance liability should include an explicit and unbiased estimate of the margin that market participants require for bearing risk • …excludes from the liability any cash flows that relate not to the liability itself • Discount rates should be consistent with observable market prices for cash flows whose characteristic match those of the insurance liability in terms of timing, currency, and liquidity • Current exit value. . . reflects its credit characteristics • An insurer should reflect acquisition costs as an expense not an asset 2 November 2006 15

Phase II Accounting – the ultimate benefit • Once adopted fair value accounting may be very good for the industry • • • 2 November 2006 Market consistent Comparable Risk based Simple to explain exit values Essentially MCEV anyway 16

Phase II Accounting – Ultimate Work • To create auditable and SOXed values will be challenging compared to today • • Fair value (exit value) of liabilities Replicating portfolios to match assets Par contracts Non-life claims Risk margins Analysis of movement Volatility of earnings and capital • But will create a better industry • And lots of work for market consistent practitioners!!! 2 November 2006 17

Key points to make • Investors and analysts are not satisfied with current disclosure by insurers • EEV has not solved the issue, and perhaps made it worse • MCEV is viewed as a positive step toward better valuations • Solvency II is also seen as a big positive • A fair value balance sheet is viewed by the IASB as the future direction for insurance 2 November 2006 18